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The Debt Crisis Ping Pong Game

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ForexNewsNow – The current twin debt crises both in the euro zone and in the US can be well described by thinking of the two entities as opponents in a ping pong match. On one side, you have the US, the hegemon with the de facto international currency that is going through tough economic times which are compounded by a staggering public debt accumulated over the past 30 years. On the other end, you have the euro zone, a younger competitor with less experience that is buckling under the weight of sovereign debt from its member states – Greece in particular.

Imagine: The game consists of sending the figurative “economic crisis ball” back and forth between each competitor. Once one competitor (ie the euro zone or the US) has reassured the viewing audience and the media, which is broadcasting the match, that he has solved his imminent economic problems (ie the US debt ceiling or the second Greek bailout), he bats the ball back to his opponent. The longer it takes to return the ball to the other side, the more the pressure grows on the player and, as a result, his currency loses value in the EUR/USD pair, and speculation as to his economic health intensifies. Once a player sends the ball back to the other side by announcing a new economic plan, prodding the relevant central bank to take action, etc., he can then rest as he watches his opponent deal with the pressure.

Of course, the game features referees (ie the major credit rating agencies, and the IMF) who are free to increase or decrease pressure on either of the competitors as they see fit and depending on how they are playing.

Now back to reality: The truth is that this is almost exactly what we have been watching for the past few months. Let’s go back to this past July.

The whole financial world was focused on the EU instability because of one country’s debt crisis: Greece. Rating agencies added to the pressure with their sovereign debt rating downgrades. Everyone was asking: How will the euro zone react? Will the region crack under the pressure?

The announcement of a second bailout plan for Greece on July 21st allowed the Old Continent to pass the debt crisis ball to the US.

The US is dealing with an imminent cause for concern for the American economy: the maximum allowable public debt ceiling is about to be reached and the government will be forced to shut down if no agreement is reached between the President and Congress to raise it by August 4th.

At the last minute, President Obama reaches a compromise with US lawmakers and the ball is batted back across the Atlantic.

In Europe there is cause for concern that Italy and perhaps Spain will be the next countries to join Greece and Ireland in requiring bailout packages. However, austerity plans are announced to help reduce their respective sovereign debt and the euro zone gets a bit of breathing room as a result and flings the economic crisis ball back to the New World.

Now the US is under the financial magnifying glass since job creation completely halts and all eyes turn to Washington to see how the President and/or the Federal Reserve will respond. Obama announces a job stimulus package plan in front of a joint session of Congress and, just like that, the hot potato is back in the euro zone’s lap.

Rumors are now swirling about an imminent Greek default – or even about the end of the EU’s single currency in its present format. There is also a buzz in the background about European banks as the European Financial Stability Facility extends its mandate to cover certain banks and IMF Chief Christine Lagarde announces that European banks require “urgent recapitalization.” The situation will last until a European leader finds a way to reassure investors about its stability and unity.

The difficulties President Obama will face in Congress as he tries to pass his jobs stimulus plan may make for the next US episode of the game.

Conclusion

This dangerous game does not only involve these two major economic entities, the rest of the global economy is also closely watching. Until the US and the euro zone come up with ways to boost the US economy and engender a stronger and more tightly-knit EU monetary bloc, both the competitors and everyone in the viewing audience stands to lose.